Ogawa: Japan looks afresh at Russian pipeline gas

Hideo Ogawa, president of Japan Pipeline Development & Operation, spoke to Interfax about the company‘s plans to build a 20 billion cubic metre per year pipeline between Japan and Russia and its possible impact on the global LNG market.

Interfax: Can you update us on the status of the project?

Hideo Ogawa: The maximum capacity of the pipeline will be 20 bcm/y and the estimated maximum cost will be ¥600 billion [$5.87 billion]. We hope to take an FID in the fiscal year 2014 [the fiscal year in Japan runs from April to March]. There will also be a full development survey and preparation for construction in fiscal 2014. Construction work would then run from fiscal 2015 to 2019.

In reality, there are no remaining hurdles to the project. The domestic barriers can be overcome and full cooperation from the Russian side would mean the project could be implemented immediately. The Japanese government has given its support to it as a private undertaking.

Q: How will the project be financed and has this already been secured?

A: The project will be 20% financed by Japanese and overseas loan and investment institutions, 40% by borrowing from Japanese government-based financial institutions, and 40% by borrowing from Japanese and overseas private financial institutions.

The project will have sufficient finances as its profit margin will maintain high stability for long-term operations.

Q: What impact do you think the pipeline will have on the East Asian gas and LNG market?

A: The delivered-at-frontier (DAF) price of pipeline gas to Japan is based on that of pipeline gas to Europe and Asia. It is very competitive because the price is much cheaper than the LNG Japan buys from overseas.

Therefore, it will depress prices in LNG contracts in the East Asian market, as well as accelerating the review of the LNG pricing system and the oil-link predominant in Asian contracts.

But it is unlikely to erode the competitiveness of Russian gas. Since Russia is the closest among the gas producing regions to the East Asian market, Russian LNG is still expected to be comparatively cheap. Gas via pipeline from Russia to Japan is also more competitive than LNG from US shale gas.

Q: Could you give us some estimates on the DAF price for the pipeline?

A: The DAF price in Europe is fluctuating between $8 and $11/MMBtu. Since $2/MMBtu is sufficient for the pipeline transportation charges, it will be possible to supply gas at $10-13/MMBtu. On the other hand, the price of LNG landing in Japan fluctuates between $16 and $19/MMBtu. An additional $1.5/MMBtu is also necessary for domestic transportation charges from the LNG plant to the customer - including LNG plant construction costs and pipeline transportation costs.

So the price of the LNG arriving at customers is $17.5-20.5/MMBtu. Therefore, gas via the Japan-Russia pipeline will be competitive enough even at $11/MMBtu - the highest level of DAF prices in Europe.

A recent analysis by the IEA chief economist [Fatih Birol] shows the price of US shale gas arriving at LNG plants in Japan will be around $13/MMBtu. Adding $1.5/MMBtu for transportation charges from the LNG plant to the customer will result in $14.5/MMBtu. So gas via the Japan-Russia pipeline is far more competitive than conventional LNG, and can also be supplied at a cheaper price than shale gas from the US.

Q: How will this affect the domestic Japanese gas market?

A: The Japanese government is going through a process for the full liberalisation of its gas and power markets. Both electricity and gas markets will have been fully liberalised by around 2019, when the pipeline is completed and gas transportation agreements are in place. The project will promote conversion to pipeline gas because it can supply gas at a much cheaper price than Japanese LNG imports.

Fuel conversion will be promoted in various areas along the periphery of the pipeline, which will make it possible to gain new customers for cogeneration in addition to conventional customers.

It will also be possible to supply cheap electricity to existing power companies and general customers by establishing low-cost pipeline gas power stations in various areas.

While Japan is promoting renewable energy, there is a bottleneck in the quality of stable supply, as well as a problem in transmission capacity. However, it will be possible to coordinatewith renewable energy to improve the stability of supply by establishing gas power stations in various areas along the pipeline to provide a backup for intermittent generation. So the pipeline will have an impact not just on the gas market, but also on the power market in Japan.

Also, the Russian side will be able to not just supply gas to the pipeline, but also enter the Japanese gas and power markets by joining the project.

Q: Could the Ukrainian crisis endanger these plans?

A: Japan Pipeline Development & Operation has been working on the project based on the principles of "separation of politics and economy" and the "borderless economy" like other US and European companies, so we hope the Ukrainian crisis will cause no major problems.

We are confident we can proceed with the project as planned without facing any pressure from the Japanese government, or the US and European governments, despite the issues in Ukraine. We recently met executives of a Gazprom group company and told them this. The Japanese government is committed to providing the necessary support to develop it as a private business.

Q: Where will the feedstock for the pipeline come from?

A: The main supply source for the project is Sakhalin 3 - which has reserves of approximately 1.4 trillion cubic metres, and the East Siberian Chayanda and Kovykta fields - with reserves of approximately 3.2 tcm. The plan is to eventually connect these fields to Sakhalin by pipeline. Since the annual gas transportation capacity of the project is 20 bcm, 500 bcm of reserves would be enough for 25 years.

In addition to Sakhalin 3, there are blocks 4 to 9 around Sakhalin, and with Magadan farther north there will be no problems with supply for many years to come.

Gas from a part of Sakhalin 3,and a part of Chayanda and Kovykta, will be sufficient for the project. Even if there is demand from Vladivostok LNG or the Sakhalin 2 expansion project, there will be sufficient gas to supply the pipeline.

Q: Some people in the industry believe the hurdles for this project are too high. What is your reply to these criticisms?

A: That view seems to be derived from either specific stakeholders or those who have no correct understanding of the present conditions. Some of the reasons put forward against the pipeline have been the lack of demand for pipeline gas; that it would prove unprofitable because of high construction costs; and that Russia is only interested in developing its LNG business in East Asia.

But after the Fukushima Daiichi accident, Japan needs to reduce its gas and power costs, and a Russian pipeline would land gas cheaper than LNG. Also, following Fukushima the government wants to build an extensive pipeline network across Japan.

Government support and deregulation concerning pipeline construction means the pipeline can be built at a lower cost. Meanwhile, Russia has only exported LNG to Asia because Japan has only wanted LNG. Post-Fukushima, this has changed.

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